A paper published by researchers from the University of St Andrews and the University of Stirling, suggests banks, venture capitalists and business angels are now being “crowded out” by equity crowdfunding platforms

Equity crowdfunding is quickly becoming a “crucial source” of early stage growth capital, new research suggests.

A paper published by researchers from the University of St Andrews and the University of Stirling, suggests banks, venture capitalists and business angels are now being “crowded out” by equity crowdfunding platforms.

Equity crowdfunding involves the owner selling an equity stake in their business in return for investment from external investors.

The research, published as part of the University of St Andrews’ Working Papers series, suggests the UK has quickly established itself as the “fastest growing equity crowdfunding market in the world”.

The research, taken from responses from 42 British entrepreneurs, found the majority – 69 per cent- stated they had turned to equity crowdfunding as a result of a “perceived lack of other financing alternatives available”.

One entrepreneur stated: “Banks are just too expensive and VCs [venture capital] want too high an amount of money.

“Also, they require you to have revenue, so when you don’t have revenue it’s a pretty hard thing to crack.

“And it’s not like Silicon Valley where people will invest in pre-revenue companies based on valuations of individuals like engineers or MBA candidates.”

The research found the borrowers it interviewed were “therefore discouraged rather than declined borrowers”.

It adds: “Very few had directly considered approaching their bank or other financial institutions, let alone had made an approach.

“No one had been turned down by a financial institution.”

The research found companies have so far raised £146 million so far this year using crowdfunding platforms like Crowdcube, Seedrs and the Syndicate Room, up front £91 million raised in 2014.

The researchers interviewed 42 British firms who have raised on average £408,000 via crowdfunding on an average of 19 per cent equity for the investment to 164 new shareholders, with five firms raising more than £1 million.

Stripping out those firms raising in excess of £1 million, the average amount raised drops to £237,339.

Many were “discouraged borrowers’, attracted by the ability to obtain finance quickly with little diminution in their equity or autonomy”, the research states.

Those firms which had used crowdfunding said they were primarily attracted to the speed with which funding can be raised – often a matter of weeks – and the lack of “strings attached”.

The research states: “Most of the entrepreneurs explained that crowdfunding offered the most attractive mechanism to retain maximum equity and autonomy, whilst still raising much needed capital.”

Adding: “Many noted that Crowdfunding offered relatively favourable valuations of their companies, in contrast to business angels, who tend to be 'tougher on price'”.

The researchers found the types of firms accessing crowdfunding were “very young, small and often pre-revenue, with the majority operating in consumer-oriented sectors such as digital media, food and drink, fin-tech and transport”.

However it also points to a “relatively low” success rate in raising finance from crowdfunding, with around 40 per cent of firms completing the funding process.

As such, the researchers state the 42 respondents from a sample of 160 entrepreneurs contacted, “should be considered atypical rather than representative of all those who start the crowdfunding process”.

The research found investors are also attracted to equity crowdfunding as it is also afforded the tax incentives enshrined in the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) originally designed to foster the business angel market.

Dr Ross Brown from the Centre for Responsible Banking & Finance at the University of St Andrews, said: “For the most part, start-ups no longer see banks as an appropriate source of funding and are increasingly viewed as archaic given the dynamic nature of the modern day start-up economy.

“By contrast equity crowdfunding is viewed as ‘fast money’ which helps new ventures to grow rapidly.

“The average size of funding raised surprised us and suggests that crowdfunding is not just a source of start-up funding but also growth finance to enable start-ups to upscale.

“While some organisations have labelled crowdfunding ‘alternative’ finance, our work suggests that ‘disruptive’ finance would be a more appropriate term.”

Co-author Dr Suzanne Mawson from the University of Stirling added: “As equity crowdfunding becomes more and more mainstream, we need to understand the impact that this type of funding has on firm development and growth over the longer-term.

“We know that equity crowdfunding can help to create jobs and to secure assets in the short term, but the real outcomes and benefits of this process will take time to determine.”

Dr Mawson added: “While undoubtedly good for start-ups the explosive growth of equity crowdfunding does raise thorny issues in terms of investor returns, especially given the valuations placed on some very nascent firms.

“Very few of the start-ups funded have given investors returns owing to the lack of ‘exits’ such as IPOs.”

Research published earlier in the month by the University of Edinburgh, taken from responses from credit experts, found 75 per cent felt crowdfunding and peer-to-peer lending poses a threat to banks and traditional lenders.